Lobbyists For Banks, Brokers Fire 1st Salvos In Battle To 'Save' Iras

May 11, 1986|By KNT News Service

WASHINGTON — Full-page newspaper ads already have sprouted: ''Warning! Someone in Washington Wants to Kill Your IRA.'' Lobbyists are peppering the media and Congress with scare stories about the attempt to ''cripple'' one of America's most popular retirement plans.

A massive political battle likely will be waged on the issue between now and June, when the Senate is expected to take up the Finance Committee's tax overhaul bill, with lobbyists for mutual funds, stockbrokers, banks and others battling to ''save'' the Individual Retirement Account.

However, the Finance Committee bill would not kill the IRA, but return to the pre-1981 law on IRAs. People still could contribute up to $2,000 a year to an IRA and the interest or profit on the IRA would remain tax deferred until withdrawal at age 59 1/2.

The main departure from current law would be that people already covered by a company pension plan could not deduct the $2,000 on their federal tax returns. Those not covered by company retirement plans still could deduct the $2,000.

At the same time, employers are likely to feel more pressure to establish such innovative retirement plans as the 401(k) plan, which is more often used by lower-paid employees because of two attractive features: payroll savings and a company subsidy that allows firms to match employee contributions.

For example, one little-noticed provision of the bill would require companies with pensions to ''vest'' their employees after five years on the job. Current law allows companies to wait up to 10 years to guarantee pension rights to an employee.

Even if no change had been proposed for the IRA, the drastic reduction in marginal tax rates would cause a corresponding reduction in the value of IRAs and all other tax shelters.

The bill would replace the current 14 rates, ranging up to 50 percent, with two rates of 15 percent and 27 percent.

For that reason alone, many Americans would find the IRAs less attractive as a tax shelter.

Here's why:

The government uses deductions to encourage and subsidize activities by taxpayers -- in this case, investing for retirement through an IRA.

For example, for people in the top 50 percent tax bracket, the government subsidizes 50 percent of the IRA by allowing taxpayers to deduct the cost of an IRA.

The wealthy person in the top 50 percent bracket would see his government subsidy cut dramatically if the top rate dropped to 27 percent, as proposed. A $2,000 IRA contribution now costs the wealthy taxpayer just $1,000 because he escapes the 50 percent tax on the contribution.

But at the 27 percent rate, his tax saving would drop from $1,000 to $540. Another example will show how the tax saving from an IRA would drop for a family with two wage earners and a combined taxable income of $65,000.

This income places them in the 42 percent marginal tax bracket, meaning that every extra dollar earned is worth just 58 cents after 42 cents in tax is taken out of it.

Last April, this family filed a joint 1985 federal income tax return with the maximum allowable IRA: $4,000. They deducted this $4,000 from their gross income, at a net taxable income of $65,000. They paid a federal income tax of $16,859.

The IRA saved them from paying $1,680 in additional taxes on that $4,000 in income that they put directly into their IRA. In effect, the government picked up 42 percent of the cost of the IRA for the couple.

Thus, to place $4,000 in the IRA account actually cost the couple only $2,320. Put another way, if they had not set up an IRA, they would have had to pay taxes on an extra $4,000 in income and their total bill would have been $18,539.

So even with no change in the IRA, the value of the deduction would have fallen because the government would be picking up 27 percent of the cost instead of 42 percent.

Yet, no one would urge keeping the marginal tax rates high just so people could save a portion of their taxes through tax shelters. No one except a lobbyist for the tax shelter industry, notes one congressional staff member.

''I'm sure they'll fight us like crazy on this one,'' he said.

The change in the law will undoubtedly affect many who use the IRA as a tax shelter, says Bonnie Newton of the Employee Benefit Research Institute, an independent non-lobbying group.

Of the 24.4 million taxpayers who have IRAs, 18 million would be ineligible to deduct further contributions from their income tax, the institute calculates.

At the same time, employers are likely to feel more pressure to establish such innovative retirement plans as the 401(k) plan, which are more often used by lower-paid employees because of two attractive features: payroll savings and a company subsidy that allows firms to match employee contributions.

In addition, the regulations on 401(k) plans allow withdrawal of the money without penalty for some expenses, such as college tuition, unexpected medical expenses, and purchase of a first home. IRA funds cannot be withdrawn without penalty until age 59 1/2.

Both the House-passed tax overhaul bill and the Senate version would preserve $7,000 worth of tax deductible contributions to a 401(k) plan. The House version would retain the IRA, but every dollar contributed to an IRA would be subtracted from the possible contribution to a 401(k).